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UK in extraordinary times - Carney

Bank of England governor Mark Carney has said the economy will move from recovery to expansion this year but insisted interest rate rises will be gradual as Britain continues to face "extraordinary times" for many years.

He said the better-than-expected recovery would mean the prospect of a rise in the cost of borrowing was now a "welcome" possibility after five years of rates being held at emergency lows.

The central bank boss told MPs on the Treasury Select Committee his flagship forward guidance policy had helped drive the bounce back in the economy, despite having to abandon linking rates to unemployment after just six months.

He said the new version that will see decisions on interest rates instead based on how quickly the economy uses up its spare capacity was an "evolution" of the initial rates pledge.

But MPs took Mr Carney to task over the policy - dubbed " fuzzy guidance" - and the Bank's failure to predict that the unemployment threshold would be reached far sooner than first predicted.

Committee chairman Andrew Tyrie said the Bank appeared to be "back to where it started" with rate-setting based on a variety of economic indicators, as it was before forward guidance was first introduced last August.

Mr Carney said his job when he took on the top role at the Bank was to support a "nascent but fragile recovery" and claimed the initial phase of forward guidance had been a success.

The rates pledge had been well understood by businesses, giving them confidence to make hiring and spending decisions, which has in turn boosted the recovery, he said.

He said: "We are moving to a period where the end of the recovery is in progress and the start of expansion should happen this year and we are moving to a period where the more conventional operation of monetary policy is a possibility , which is welcome."

He admitted the Bank's forecasts had been woefully wrong, having first predicted unemployment would not reach 7% until 2016 - a threshold that is set to be hit within months.

It has been holding an internal review of its forecasting capability and is set to report the findings next week, he said.

The Bank last week held rates once more, marking t he five-year anniversary of its decision to slash rates to the historic low of 0.5%.

But members of the MPC have repeatedly signalled that rates may rise next year as the economic recovery picks up pace, with the market expecting a hike at the start of the second quarter.

Mr Carney reiterated his message to MPs that rate rises will not risk choking off the recovery, having already said that borrowing costs would have to stay well below pre-recession levels of around 5% for the next few years.

He reassured them that the 2015 general election would have no bearing on interest rate decisions.

"When the time comes - a welcome time - to raise rates, we expect it to be gradual and the degree to be limited," he said.

"We will still be living in extraordinary times a few years down the road," he added, referring to the slow recovery in Europe, emerging market turmoil and higher borrowing costs in financial markets.

Deputy governor Charlie Bean said in a speech yesterday that rates are likely to settle around 2% to 3% ''for some while''.

However, this "new normal" for rates is unlikely to mean mortgage borrowers benefit from lending costs staying below 5%, according to the Bank.

Mortgage rates are already far higher than base rate, at around 3% to 4%, and the so-called spread is set to remain the same.

Mr Carney also told MPs the Bank's £375 billion quantitative easing (QE) programme would not be scaled back until there had been "several" rate rises to ensure the recovery is not put at risk.

Shadow chancellor Ed Balls warned that Mr Carney may be forced to raise interest rates earlier than he wishes by the "lopsided" housing market, which has seen prices rise much faster in London and the South East than in other parts of the country.

Mr Balls urged the Government to build more houses to bring demand for homes more in line with supply. And he called for a cut in the £600,000 limit for support under the Help to Buy scheme.

Writing in the Evening Standard, Mr Balls said: "We have a lopsided housing market because rising demand is simply not being matched by rising supply. And the danger is that the Bank of England governor may be forced to act to rein in the housing market in some parts of the country and we'll see rising interest rates for all.

"A premature rise in interest rates would hit family finances hard and undermine prospects for an investment-led recovery. That is why George Osborne must listen to the CBI and the IMF and act in the Budget to boost investment in housing supply."

Mr Balls added: "I believe the new governor of the Bank of England is right to be worried that the recovery is not yet secure or balanced. That is why it is vital that the Chancellor acts to support growth and investment by getting more homes built for the millions who aspire to get on the housing ladder.

"I back the Help to Buy scheme, though the limit should be brought down, because the taxpayer should not be guaranteeing mortgages on homes worth as much as £600,000. But soaring house prices and a shortage of homes mean the very first-time buyers the scheme should be helping are finding it ever harder to afford a home of their own."

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